Many companies and businesses use accrual basis accounting. With respect to accrued expenses (as opposed to accrued revenue), the process for obtaining and preparing the data needed to determine the amount of accrued expenses can be burdensome for both the company and its vendors.
For example, some vendors (e.g., law firms providing legal services) typically bill for their work on an hourly basis. Consequently, neither the law firm nor the company authorizing the legal work will know the exact amount of expenses incurred by the law firm on the company's behalf until (i) all the outside lawyers and the law firm's staff have entered their time in the law firm's time & billing system, (ii) the responsible users at the law firm have reviewed the time and made any appropriate corrections, and (iii) the law firm has actually generated an invoice for the work performed. Consequently, corporations rarely receive the actual invoice for worked performed until many days after the end of the month, and in some situations the company may not receive its invoices until months after the work was performed. However, the company's finance department may need information about accrued expenses before the end of the month (or very soon after the end of them month) to timely prepare the company's financial statements. In this situation, the company must contact its law firms before having received any invoices. Moreover, if data must be provided before the end of the month, the law firm will not know the exact amount of billing and can provide only an estimate as to the future amount of time its users will incur through the end of the month.
Below are descriptions of three typical processes used by corporate law departments for obtaining and providing accrual expense amounts to their finance departments. The first approach requires each law firm or vendor (collectively referred to as “firms” or “vendors”) to submit unbilled amounts in a spreadsheet at the end of the fiscal year. During the year, a corporate law department using this approach uses its internal company budget (“Departmental Budget”) for the fiscal year to provide an accrual amount to the company's finance department at the end of each month. For example, assume the Departmental Budget contains $10,000 each month for spending by Firm A in Matter X. Consequently, each month the law department sends $10,000 as the accrual amount for Firm A in Matter X.
The second approach uses a multicolumn spreadsheet containing three columns for each month: one column for the original Departmental Budget estimate for the month, a second column for the firm's estimate of its invoice amounts for the month, and the third column for the actual spending. Each row in the spreadsheet is a matter on which the firm is working. Before the end of each month, firms are required to submit their estimate of the amount to be billed for the month for each matter, which the company then enters into the master-multicolumn spreadsheet. At the same time the company will update the spending for each applicable month (assuming invoices have been received since the last time the spreadsheet was updated). Then, at the end of each month the company will produce an accrual amount by summing up the firm estimate of the invoice amounts for the current month and all prior months in the fiscal year, and subtract from that the sum of all actual spending. The accrual amount at the end of each month is determined by (i) adding all of the firms' billing estimates for each month through the end of the current month and (ii) subtracting the sum of all the actual amounts invoiced from each month. The purpose of the Departmental Budget column is to provide a reality check each month when the firms submit their billing estimate for each month, but it is not actually used in the calculation of the accrual.
The third approach requires each law firm or vendor to submit a final invoice for the fiscal year before the end of the fiscal year, and such invoice must include an extra line-item for the amount that the firm or vendor expects to bill for the remainder of the year. For example, assume that December is the final month in the fiscal year. The law department will instruct its firms to submit a final invoice for the year by December 20, and the invoice must include all actual time through December 15 and a separate line item for an estimate of billing from December 16-31. The law department will then actually pay the full amount of the invoice. The law firm will be instructed to then submit its actual invoice for December 16-31 time in January. If the firm overestimated, then the excess amounts will be deducted from future invoices in the next year (and if the amount is too large, then the firm will issue a reimbursement check). If the firm underestimated, then the company will pay the excess amount.